Header graphic for print

Franchise Law Update

Commentary on Business and Legal Issues of Franchising

ABA Forum on Franchising Early Bird Registration Ends Today

Posted in Industry Updates

4147809_m (1)“Early Bird Registration” for the American Bar Association Forum on Franchising ends today!  The ABA Forum on Franchising will be held this year from October 15-17, 2014, at the Sheraton Seattle Hotel in Seattle.   The ABA Forum on Franchising is one of the best ways to (1) meet fellow legal practitioners in the franchise field, (2) learn about legal updates affecting franchise systems and (3) obtain CLE credit for attending plenary sessions, workshops and intensive programs on substantive legal franchise issues.    The program always does a good job covering topics of both transactional and litigation interest.  There are significant discounts in registration for Young Lawyers and 1st and 2nd time attendees so this is a cost-effective way to introduce and educate your less experienced franchise lawyers in your firm or company.   Each year the program offers a number of social events.  This year the Forum is introducing “Restaurant Rounds” where it will pair up attendees in random groups of 10 for dinner on Wednesday night.   This is one additional way for attendees to socialize and meet new people in the field.   For a complete description of the program, list of workshops and registration form click HERE.

Seattle Minimum Wage Battle Continues

Posted in Business Updates

seattle skylineOn May 24, 2014, the Seattle City Council passed an ordinance requiring a phase in over a number of years to a minimum wage of $15 per hour. The prior minimum wage was $9.32. This would make the minimum wage in Seattle amongst the highest in the US.

Clearly, this effects all independent franchised businesses. But there is another aspect to the law which further concerns franchisees. In the ordinance, a franchisee is treated like a big business if it is part of a franchise system with over 500 employees – and the ordinance counts employees of all franchisees in the system. So, even if a franchisee has 10 employees, if franchisees in the system have 500 or more employees, the individual franchisee will have to comply with a substantially faster phase in of the requirement by 2017 – or by 2018 if they pay towards an employee’s medical benefits plan.

A coalition of Seattle businesses called “Forward Seattle” attempted to gather petition signature to put the general issues relating to the minimum wage increase to voters on the November ballot. Despite announcements that the signatures were submitted, the group announced on July 23 that the attempt had failed.

The International Franchise Association filed a lawsuit in US District Court on June 11 to invalidate the ordinance claiming in part that it violates the Constitution by treating independent franchised businesses and other small businesses unequally. For more information about this suit and issues concerning franchisees in this ordinance, see www.SeattleFranchiseFairness.com.

Shocking NLRB Decision: Franchisor and Franchisee Are “Joint Employers”

Posted in Legal Decisions, Regulatory Compliance

Today the NLRB Office of General Counsel authorized complaints against McDonald’s franchisees and determined that McDonald’s USA, LLC, the franchisor, is a “joint employer” of the employees of franchisees.

friesMcDonald’s has been the target of a continued effort by the Service Employees International Union.  Franchisee employees have variously alleged that they were fired for joining labor unions, were underpaid, or had expenses deducted that left them earning less than minimum wage.

According to the Wall Street Journal, McDonald’s said in a memo distributed to franchisees that there is no legal or factual basis for the NLRB’s finding that the employees are joint employees of the franchisor and franchisee and that it will vigorously defend the expected administrative trials and appeal processes likely to follow the complaints.

Today’s shocking–and legally incorrect, if you ask me–decision from the NLRB general counsel could upend the franchise industry, making franchisors responsible for the employment practices of their franchisees even when they do not control those franchisees. If upheld, it also portends more aggressive efforts by unions to organize the employees of the franchise industry. In my opinion, this fight makes all the vicarious liability cases that have come before look tame in comparison.

Little Noticed POM Wonderful Decision Could Result in New Mislabeling Lawsuits

Posted in Legal Decisions

The Supreme Court again this summer was the focus of immense media and public scrutiny. Much of that scrutiny revolved around the High Court’s decision in the Hobby Lobby case, where the Court concluded that some closely-held corporations have religious freedom rights pursuant to the First Amendment to the Constitution. While arguably novel and announced by a divided Court, the Hobby Lobby decision was not completely unexpected, as it flows pretty generally and directly from the Court’s decision in Citizens United.

While the Hobby Lobby decision has the potential to impact the franchise industry, I believe that the considerably less talked about–and unanimous (8-0, with Justice Breyer not participating in the consideration or decision)–decision in POM Wonderful LLC v. Coca-Cola Company likely has far greater potential to impact the franchise industry in the long term.

PomegranatesPOM Wonderful produces, markets, and sells a pomegranate-blueberry juice blend. Coca-Cola makes and sells a competing juice blend under its Minute Maid brand consisting of 99.4% apple and grape juices, 0.3% pomegranate juice, 0.2% blueberry juice, and 0.1% raspberry juice.  The Court itself stated “[d]espite the minuscule amount of pomegranate and blueberry juices in the blend, the product is prominently labeled “pomegranate blueberry” juice in all capital letters.  While the Minute Main label discloses that its juice is a “flavored blend of 5 juices” and “from concentrate with other flavors”, those words appeared in much smaller type. Furthermore, the Court also noted that the Minute Maid label displays a vignette of blueberries, grapes, and raspberries in front of a halved pomegranate and halved apple.

POM sued Coca-Cola under the Lanham Act, claiming that the Minute Main label tricked and deceived consumers. While better known for its trademark provisions, the Lanham Act permits companies to bring suit when their sales or business reputation is injured by the false advertising or marketing of a competitor. Specifically, POM’s suit claimed that the name, label, marketing and advertising used by Minute Maid misled consumers into believing the product consists primarily of more expensive pomegranate and blueberry juices when it really consists primarily of less expensive apple and grape juices. The consumer confusion that resulted caused POM, it alleged, to lose sales.

Coca-Cola, for its part, defended the POM lawsuit by pointing to the Federal Food, Drug and Cosmetic Act (FDCA). The FDCA authorized a statutory scheme designed primarily to protect that health and safety of the public at large, and the Act prohibits the misbranding of food or drink. Misbranding includes labeling that is false and misleading, if required information is not prominently displayed, and/or the label does not disclose the common or usual name of the foodstuff inside the packaging. Of particular importance here is that the Food and Drug Administration (FDA) had issued regulations regarding the labeling of juice blends, but that the Government–unlike the situation with prescription drug labels, for example–does not preapprove juice labels.

The critical issue in the case was the intersection of the Lanham Act and the FDCA because the FDCA provides the Federal Government with near-exclusive enforcement authority; i.e., the FDCA does not authorize private suits. Both the trial court and the Ninth Circuit Court of Appeals agreed with Coca-Cola, finding that the comprehensive FDA regulatory scheme enacted pursuant to the FDCA barred POM’s Lanham Act claim.  The Supreme Court disagreed. The Court placed great weight on the fact that a textual analysis of both statutes disclosed no Congressional intent to bar unfair competition claims of the type brought by POM. The textual analysis was bolstered by the fact that both laws had coexisted for over 70 years and, in that time, Congress had not chosen to preclude Lanham Act claims on food labeling when it had pre-empted state laws in the same area. Additionally, the Court noted that while the Lanham Act and FDCA complement each other in various ways, they are intended to address different issues. The Lanham Act protects commercial interests while the FDCA protects public health and safety. Moreover, the Court explained that competitors are likely to notice unfair practices in a more accurate and immediate fashion. At the same time, the Court believed the likelihood of inconsistent national results to be low.

It seems that this decision has the potential to open a Pandora’s Box of labeling questions for any franchisor and its franchisees in the food and beverage industry. While the intent of the Court seems noble and genuine, food and drink purveyors will no longer be able to rely upon the carefully considered and developed federal regulations alone. They will also need to consider whether one of their competitors will conclude that their labeling, advertising or marketing is “misbranded” and sue. The bar for a successful lawsuit will admittedly remain high–companies, including POM Wonderful on remand, will still need to prove an injury such as lost sales to be successful. Nonetheless, new Lanham Act lawsuits based on alleged mislabeling and “misadvertising” of food and beverages are likely to proliferate. And, as anyone who has been involved in such suits can attest, they are costly to defend.

Mobile App Use: Are You Considering the Privacy and Security Risks?

Posted in Business Updates

Today it seems like there is an application for everything.  From banking to shopping, individuals have become accustomed to using mobile applications to perform some of the most privacy sensitive tasks.  Similarly, as the world becomes more technologically savvy, mobile applications have become a fenceswidely used outlet for conducting business.

As mobile applications increasingly become a part of everyday business practices, businesses must carefully consider the privacy and security risks.  To address this issue, the FTC recently released the publication “Business execs: 7 things to consider before using that app” in which it encourages businesses to:

  1. Choose Applications Wisely – Consider what information the application collects, how the application will use the information, and how the application protects data during transition and storage.
  2. Use a Secure Network – When using an application to conduct sensitive transactions (accessing accounts, using a credit card, transmitting confidential information), make sure your mobile device is connected to a secure location.
  3. Consider Wi-Fi Risks – When using Wi-Fi to utilize an application, use password protected Wi-Fi hotspots.
  4. Use Mobile Websites – Though applications are convenient, they can be risky when used with a non-secure network.  If business must be conducted via a non-secure network, consider using the mobile website instead of an application (this may offer more protection).
  5. Get a VPN – If your employees regularly send sensitive data using applications or WiFi hotspots, consider obtaining a virtual private network (VPN ) for your company.  The VPN will encrypt traffic between the employee’s computer and the internet.
  6. Maintain In-House Applications – If your company has an in-house application, regularly update the application to promote security.
  7. Talk to Your Employees – Make sure all employees and co-workers are aware of mobile application best practices.

In addition to the above, always encourage your employees to regularly install computer, mobile device, and application updates to decrease the chance of a security breach.

Through following these best practices, businesses can decrease the risk of privacy and/or security breaches, protecting its clients/customers, as well as itself!

Tesla: The Pennsylvania Compromise

Posted in Legislative Updates

autodealerIn what now appears to be an inexorable march through the Northeastern states, a bill (Senate Bill 1409) providing for the creation of up to five Tesla stores in Pennsylvania passed out of the Pennsylvania Senate late last week.  It now heads to the Pennsylvania House of Representatives for consideration. Given that the Pennsylvania Automotive Association–the Pennsylvania statewide dealers association–supports the bill, it is likely to find success in the House Chamber as well.

Interestingly, and in contrast with a number of other states where state dealer associations have attempted with some success to block statutes that would permit Tesla to sell directly to the public, the state dealers Association supported the original bill.  A spokesman for the Association speaking with Automotive News noted that the tide of public opinion seemed to be changing, and that the dealers wanted to get in front of the trend.  At the same time, the Association also obtained certain changes in Pennsylvania dealership laws that will make it tougher for another manufacturer to open stores

The bill’s consideration and passage was not without controversy.  An original version of the bill did not have any limits on the number of stores Tesla could open in Pennsylvania. The Alliance of Automobile Manufacturers–a group of 12 auto manufacturers that does not include Tesla–objected to the lack of such limits.  The Alliance argued that allowing Tesla an unlimited number of stores would give Tesla an unfair advantage in the hyper-competitive world of auto retailing.  After some haggling, the five store compromise was born.

What does The Pennsylvania Compromise ultimately mean? For one thing, Tesla clearly seems to be finding, it not a welcoming, at least not a hostile reception in most states in the Northeastern United States. For another, it allows Tesla to test its direct-to-consumer sales model in a block of large, populous states from Ohio to Massachusetts. Nonetheless, this compromise, though, sets up potentially difficult conflicts down the road.  Will five stores be enough for Tesla, a company that wants to sell hundreds of thousands, if not millions, of vehicles within the decade? Will this crack in the franchise model of auto sales open the door for other manufacturer challenges in the future, maybe in the courts?  Will consumers embrace the ability to purchase cars directly from the manufacturer, as they have with so many other things like shopping for clothes online?  And what will the mean for dealers, who are often some of the biggest, most prominent and locally active businesses in the local communities?  Only time will tell.

The Top Three Insurance Issues Facing Franchise Systems

Posted in Business Updates

As a member of our firm’s insurance practice group, I am often asked by clients to conduct comprehensive insurance policy analyses to identify gaps in coverage and uninsured risks.   When conducting these analyses for franchise systems I also typically provide a mark-up of the franchisor’s form franchise agreement with my suggested edits and comments.   I thought I would pass along my list of the top 3 issues I come across when reviewing franchise agreement insurance provisions:

  1. The franchise agreement requires a “Certificate” as evidence of a Franchisor’s Additional Insured Status.  Certificates of Insurance confer NO RIGHTS TO THE HOLDER.  It says so right across the top of the Certificate.  It is useless for this purpose.  You must always receive an endorsement to the policy clearly showing the franchisor as an additional insured and your franchise agreement should require as much.   Otherwise, a franchisor can wind up without coverage under its franchisees’ policies.
  2. The franchise agreement does not provide enough flexibility to change coverage requirements.  Franchise agreements should always provide that coverage requirements can be increased or decreased upon the franchisor’s prior notice as set forth in the Operations Manual or other writing.briefcase  Surprisingly, many franchise agreements outline detailed requirements and coverage limits but do not specifically provide that the franchisor can change these standards as it deems necessary during the franchise term.
  3.  The franchise agreement only requires the franchisee maintain insurance during the term of the franchise agreement.   Professional liability policies and certain other policies are typically “claims made” – not “occurrence” based.  To protect against claims brought after the franchise agreement terminates or expires under claims made policies, the franchise agreement should require the franchise maintain insurance during the term and for such period after as necessary to provide coverage required for events occurring during the term of the franchise agreement.

Another big issue I encounter is lack of compliance by franchisees and a failure for franchisors to pick up on it.  Many times a franchisee’s policy will exclude coverage require by a franchise agreement or have much lower limits than required.  This is true even when a franchise system has a recommended broker or vendor who custom builds a coverage package for franchisees to purchase.  Franchise systems should always have someone who understands insurance policies review both the system’s coverage and each of the franchisees.

For Private Companies: Good News–Simplifed Accounting Rules Have Arrived

Posted in Business Updates

Continuing an occasional series of guest posts, today’s post is contributed by Mike Rodrigues, CPA, Senior Audit Manager, WithumSmith+Brown

In January 2014, two new accounting standards were issued providing accounting alternatives specifically for private companies. The simplification provided by these standards is elective, not mandatory. A private company may choose to adopt one standard but not the other, both standards, or neither.

Goodwill: May elect to amortize

The new goodwill accounting standard allows a private company to amortize goodwill on a straight-line basis prospectively over ten file00014008231years, or less, if it believes a shorter useful life is more appropriate. Existing goodwill is eligible for this election. Because goodwill will become a dwindling asset, the new accounting standard will also generally excuse private companies from performing impairment tests for goodwill. A pared-down impairment test would only be performed upon occurrence of certain negative, triggering events. The streamlined test may be performed at the entity-wide level, or at the reporting-unit level, in a one-step exercise. The amount of goodwill impairment would represent the excess of the entity’s carrying amount over its fair value. We at WS+B believe many private companies will appreciate the reduced cost and complexity that the election to amortize goodwill offers.

Interest rate swaps: May elect to apply simplified hedge accounting

Private companies often find it difficult to obtain fixed-rate borrowings. Consequently, many enter into interest rate swap agreements with financial institutions to convert their variable-rate debt into fixed-rate debt. The Financial Accounting Standards Board (FASB) believes many private companies lack the desire or expertise to comply with the complexities of hedge accounting. Therefore, many private companies do not enjoy the primary accounting benefit of hedge accounting, and must flow the interest rate swap’s fair value changes through their income statement. The new accounting guidance for interest rate swaps will offer a practical expedient for private companies, other than financial institutions. Election of this alternative will allow private companies to qualify for hedge accounting for certain interest rate swaps used to convert variable-rate borrowings to fixed-rate borrowings that meet certain criteria. Key features of the simplified hedge accounting for such swaps are:

  • The changes in swap value will go through other comprehensive income, not the income statement.
  • Relaxed hedge documentation requirements.
  • Reduced fair value disclosure requirements if the swap is the only derivative.

These revised standards will be of use to many private companies, including franchisees and franchisors.

Plain Language Matters: Engine Manufacturer Held Not a Franchisor Under New York Dealer Law

Posted in Legal Decisions

The New York District Court recently ruled that a truck engine manufacturer was not a franchisor under the New York Franchised Motor Vehicle Dealer Act (Dealer Act).

In 2013, Daimler Trucks North America, LLC (Daimler Trucks) terminated its Freightliner truck  franchise agreement with the plaintiff, Agar Truck Sales, Inc. (Agar), a dealer located in New York, for failing to meet certain sales requirements under the agreement.  Shortly after, a wholly owned subsidiary of Daimler Trucks, Detroit Diesel Corporation (DDC), also terminated its engine franchise agreement with Agar.  DDC sold Agar Detroit Diesel engines for approximately 25% of the Freightliner vehicles it purchased from Daimler Trucks.   Agar brought suit against both Daimler Trucks and DDC for terminating the agreements without due cause or good faith.file2811244091888

DDS filed a motion to dismiss arguing that it was not a “franchisor” under the Dealer Act and therefore termination restrictions under the Dealer Act did not apply.   Agar conceded that DDS did not meet the definition of a franchisor under the Dealer Act but argued nonetheless DDC should be held liable because the “Detroit Diesel franchise is part and parcel to of the Freightliner franchise, because DDC’s action must be imputed” to Daimler Trucks.

The court ruled that DDC was not a franchisor because it manufactured engines and not vehicles and a plain reading of the Dealer Act made it clear that vehicle parts manufacturers are not covered.  The court granted DDC’s Motion to Dismiss Agar’s count against it since DDC could not be held liable as a franchisor under the Dealer Act.  The court did, however, allow Agar leave to amend its complaint to allege violations of the Dealer Act by Daimler Trucks due to the termination of the DDC franchise agreement under a section of the Dealer Act making it unlawful for a franchisor to use a subsidiary to accomplish what would otherwise be unlawful conduct under the Act.

It is always welcome to see a decision where a court applies the plain language of a franchise statute in the way the legislature intended and not judicially expand the scope of a state franchise relationship law. It is important to keep in mind, however, that careful corporate structuring by itself will not relieve a franchisor of liability for violations of state franchise termination restrictions by its subsidiaries.   If you can’t do something legally–such as terminate a franchisee–then your subsidiaries probably can’t do so either.


Are Your Restrictive Covenants Still Enforceable in Pennsylvania?

Posted in Legal Decisions

A recent published opinion from the Superior Court of Pennsylvania, an intermediate state appellate court, has called into question the enforceability of some restrictive covenants in Pennsylvania.  In David M. Socko v. Mid-Atlantic Systems of CPA, Inc., the Superior Court considered whether the Uniform Written Obligations Act (“UWOA”), as adopted in Pennsylvania, permitted the enforcement of a restrictive covenant entered into after the beginning of employment and without additional consideration. The Court decided that such a restrictive covenant cannot be enforced.

waterfallThe facts were straightforward. Socko, a salesman, having once left the company, signed onto a second period of employment with Mid-Atlantic in June 2009. At that time, Socko signed an employment agreement with a two-year covenant not to compete. Then, in December 2010, while still employed by Mid-Atlantic and without any new consideration, Socko signed another employment agreement, this one also containing a two-year covenant not to compete. This new covenant would only begin to run upon termination and included an expanded territorial restriction of any jurisdiction where Mid-Atlantic does business.

You can guess what happened next. Socko left Mid-Atlantic to go to work for a competitor. Mid-Atlantic sent a letter to the competitor, enclosing a copy of the non-competition agreement and threatening litigation. Socko was then terminated by the new employer. Socko filed suit, seeking a declaration that the covenant not to compete was unenforceable because it was not supported by adequate consideration. Mid-Atlantic did not deny that no consideration had been given to Socko in exchange for the 2010 non-compete. Instead, it argued because the UWOA prevents the avoidance of any written agreement for lack of consideration, the 2010 covenant had to be enforced. The trial court granted summary judgment to Socko, and Mid-Atlantic appealed.

On appeal, the Superior Court engaged in a broad review of the history of non-competition agreements in Pennsylvania, as well as decisions of federal district courts in Pennsylvania that had considered the effect of the UWOA on such agreements under Pennsylvania law. In that sweeping review, the Superior Court noted that the Pennsylvania Supreme Court has long disfavored covenants not to compete because they are restraints on trade that may prevent former employees from earning a living. As such, a covenant must be entered into when beginning initial employment (“ancillary to the taking of employment”) or accompanied by new consideration, such as a corresponding benefit to the employee (for example, a bonus specifically linked to the non-compete and not related to anything else) or a beneficial change in employment status (like a promotion to a new position). Moreover, the Superior Court noted the Supreme Court had regularly examined the quality of the consideration given in exchange for signing a non-compete agreement, rejecting recitations of value like “good and valuable” consideration readily accepted in other contractual circumstances.

The Superior Court therefore examined the Socko scenario to see if Socko received valuable consideration in exchange for the December 2010 covenant not to compete. It decided that language added to a contract to the effect that the parties intended to be legally bound–even if perfectly adequate for other contracts–would not suffice for contracts that restrain the ability of employees to seek new employment. The Court analogized to contacts under seal, which Pennsylvania Courts had long held provided insufficient consideration to support a restrictive covenant, saying that the UWOA had precisely the same legal effect, “namely to import consideration into a contract and thus eliminate the need for proof of the existence of consideration”.

This decision provides a good reason to review any covenants not to compete you have with employees that are governed by Pennsylvania law. If they were not entered into at the beginning of an employment relationship or supported with either a corresponding benefit like a special bonus or a positive change in job status, the UWOA will not supply a reason for restrictive covenants to be enforceable in Pennsylvania. Even more, while it does not seem to have happened in this case, recall that Mid-Atlantic did send a letter to the new employer threatening litigation. That letter led to Socko’s termination. The failure of a non-compete for lack of consideration likely means that a former employer has opened itself up to lawsuits from both the former employee and new employer for tortious interference with contractual relations. If the employee is a high performing salesperson, success in such a suit could lead to significant damages.